Finance 539 Quantitative Portfolio Management - Vanderbilt ...

Finance 539
Quantitative Portfolio Management
Owen Graduate School of Management
Professor Craig M. Lewis
Fall 1998 – Module I
Overview
This course is designed to cover the subject of quantitative portfolio management. As the
title suggests, we examine a particular aspect of the portfolio management process that
focuses on quantitative stock selection. Over the term we will develop analytic tools that can
help us make informed investment decisions.
Teams
By the end of the second class, you will be expected to join a team of from three to five
members. Teams will submit all exercises, and your grade will depend in large part on the
quality of the work of your team.
Grades
Grades will be given to each team based on overall performance on the exercises. Each
individual on the team will receive the team grade modified to account for individual
performance on oral reports.
Course Website
Some of the course materials are available on the course website at
http://mba.vanderbilt.edu/faculty/Craig.Lewis/Finance539.htm
Course Text and Readings
The following book is the required test for the class.
• Richard C. Grinold and Ronald N. Kahn, Active Portfolio Management, Probus Publishing,
Chicago, Ill., 1995
The following books provide alternative discussions of the topics covered in Grinold and
Kahn.
• Edwin J. Elton and Martin J. Gruber, Modern Portfolio Theory and Investment Analysis, Fifth
Edition. New York: John Wiley and Sons, Inc. 1995.
• David G. Luenberger, Investment Science, Oxford University Press, 1998.

• William F. Sharpe, Macro Investment Analysis Course Materials, http://wwwsharpe.stanford.edu/328_97.htm,
1997
Course Material
Introduction
Matrix Algebra
Matrices
Matrix Operations
Gauss
Lewis lecture notes
Optimization
Portfolio Selection Problem
Lewis lecture notes, Word file for download
Asset Pricing Models
Portfolio Theory
• Lewis lecture notes, Word file for download
The Capital Asset Pricing Model
• Richard Roll, A Critique of the Asset Pricing Theory’s Tests; Part I: On Past and
Potential Testability of the Theory, Journal of Financial Economics, 4, March 1977, 129-
178.
• Chapter 2, Grinold and Kahn, “Consensus Expected Returns: The Capital Asset
Pricing Model”
The Arbitrage Pricing Theory
• Chapter 7, Grinold and Kahn, “Expected Returns and the Arbitrage Theory”
Factor models
• Lewis lecture notes – Risk Control Models - download
• Chapter 3, Grinold and Kahn, “Risk”
• Chapter 8, Luenberger, “Models and Data”
• W.F. Sharpe, “Factor Models, CAPMs, and the APT,” Journal of Portfolio Management,
Fall 1984, pp. 21-25.
• Eugene Fama and Ken French, “The Cross-Section of Expected Returns,” Journal of
Finance, 47, June 1992, 427-466.
• Eugene Fama and Ken French, “Common Risk Factors on the Returns on Stocks
and Bonds,” Journal of Financial Economics, 33, February 1993, 3-56.

• Wayne Ferson and Cambell Harvey, “The Risk and Predictability of International
Equity Returns,” The Review of Financial Studies, 6, 1993, 527-566.
• Lewis lecture notes, Word file for download
Homework #1 – Portfolio Theory and the DOW 30,
• Solution to HW #1 – effset.m
Homework #2 – Factor Models – Fama-MacBeth Approach
• Solution to HW #2 – not yet
Homework #3 – Factor Models – Fama-French Approach
• Solution to HW #3 – not yet
Active Portfolio Management
Measuring Exceptional Stock Price Performance
• Chapter 4, Grinold and Kahn, “Exceptional Return, Benchmarks, and Value Added”
• Brad Barber and John Lyon, “Detecting Long-Run Abnormal Stock Returns: The
Empirical Power and Specification of Test Statistics,” Journal of Financial Economics,
43, March 1997, 341-372.
• John Lyon, Brad Barber, and Chih-Ling Tsai, Improved Methods for Tests of Long-
Run Abnormal Stock Returns, July 1997, unpublished working paper.
Residual Risk and Return: The Information Ratio
• Chapter 5, Grinold and Kahn, “Residual Risk and Return: The Information Ratio”
The Fundamental Law of Active Management
• Chapter 6, Grinold and Kahn, “The Fundamental Law of Active Management”
Valuation
Readings
• Chapter 8, Grinold and Kahn, “Valuation in Theory”
• Chapter 9, Grinold and Kahn, “Valuation in Practice”
• J. Abarbanell and B. Bushee, “Fundamental Analysis, Future Earnings, and Stock
Prices,” Journal of Accounting Research, Spring 1977, 1-24.
• S. Stickell, “Reputation and Performance Among Security Analysts,” Journal of
Finance, December 1992, 1811-1836.
Portfolio Implementation
Information Analysis
• Chapter 11, Grinold and Kahn, “Information Analysis”

• Keith Ambachster and James Farrell, Jr., “Can Active Management Add Value?”
Financial Analysts Journal, November/December 1979, 39-47.
• Ronald Kahn, “What Practioners Need to Know About Backtesting,” Financial
Analysts Journal, July/August 1990, 17-20.
Portfolio Construction
• Chapter 12, Grinold and Kahn, “Portfolio Construction”
• Vijay Chopra and William Ziemba, “The Effects of Errrors in Means, Variances, and
Covariances on Optimal Portfolio Choice,” Journal of Portfolio Management, 18, Winter
1993, 6-11.
• Phillippe Jorion, “Portfolio Optimization in Practice,” Financial Analysts Journal,
January/February 1992, 68-74.
Transaction Costs, Turnover, and Trading
• Chapter 13, Grinold and Kahn, “Transaction Costs, Turnover, and Trading”
Performance Analysis
• Chapter 14, Grinold and Kahn, “Performance Analysis”
• W. Goetzmann and R. Ibbotson, Do Winners Repeat?” Journal of Portfolio Management,
Winter 1994, 9-18.
• W.F. Sharpe, “The Sharpe Ratio,” Journal of Portfolio Management, Fall 1994, 49-58.
Homework #4 – Alpha Models
• Solution to HW #4 – not yet
Dynamic Portfolio Strategies
Asset Allocation
• Chapter 15, Grinold and Kahn, “Benchmark Timing”
• W.F. Sharpe, “Asset Allocation: Management Style and Performance Measurement,”
Journal of Portfolio Management, Winter 1992, 7-19.
• Joe Brocato and P.R. Chandy, “Does Market Timing Really Work in the Real World?
Journal of Portfolio Management, Winter 1994, 39-44.
• Robert Cumby and David Modest, “Testing for Market Timing Ability,” Journal of
Financial Economics, 19, 1987, 169-189.
Style Analysis
Readings
• Stephen Brown and William Goetzmann, “Mutual Fund Styles,” Journal of Financial
Economics, March 1997, 373-400.

• John Christopherson and C. Nola Williams, “Equity Style: What It Is and Why It
Matters,” The Handbook of Equity Style Management, Edited by T.D. Coggin and F.J.
Fabozzi, published by Frank J. Fabozzi and Associates, 1995 pp. 1-22.
• W.F. Sharpe interview on Style Analysis